Export Opinion: Transfer Pricing Developments in China

China General Interest

Ernst & Young's China Business Group brings us up to speed on the latest developments in the world of Transfer Pricing.

A major change in China’s transfer pricing regime occurred last month, albeit with much less fanfare than recent Chinese New Year celebrations.

Transfer pricing is an area of international tax law surrounding related party transactions. This often applies to companies with parents or subsidiaries overseas, and multinationals. Transfer Pricing rules are a fairly recent (and still developing) feature of an increasingly globalised world. In the absence of an international framework in this area, there is an incentive for companies to charge artificial prices when transacting with one another, thus shifting profits to low-tax countries, and reducing the overall tax burden of the group. Much of the world, including New Zealand, has adopted the OECD guidelines, which set documentation requirements, and approved methodologies for establishing a fair or 'arm's length' price.

Long out of step with the developed world, the Chinese government has since the early 1990s been establishing the beginnings of a transfer pricing regime, which in the past had been seen as subjective (there was no law governing the behaviour of individual tax officials). Tax avoidance through transfer pricing was common; this eroded the tax base and caused foreign investors to have a jaundiced impression of the profitability of Chinese operations.

As of 16 December 2008, the State Administration of Taxation now requires a total of nine related party forms to be submitted as part of the annual corporate income tax filings. These forms require both domestic and foreign owned businesses to submit information on related parties and associated transactions; sales and purchases of goods and services for both related and unrelated parties; along with the transfer pricing method used (similar to those found in the OECD guidelines). There are also forms covering the transfer of fixed assets and intangibles, such as patents or copyright; outbound investment; and outbound payments – for example royalties, dividends, and interest.

Although not as comprehensive as the OECD guidelines, the new regime represents a step forward for the Chinese taxation authorities, and a significant development for business.

The impact on companies with interests in China may not be as great as initially thought. Much of the information required is already embedded in general ledger accounts – so the majority of data gathering can probably be automated in future. The most time consuming compliance is likely to be in specifying the transfer pricing method used, and how that figure has been arrived at.

Transfer Pricing is a critical issue for all multinationals, and one that requires effective global tax planning. The importance of being proactive in preparing transfer pricing documentation cannot be overlooked in a climate of increasing regulatory activity. Providing robust documentation at the first instance could make the difference between a cursory glance, and a full scale review by the taxation authorities.

Ernst & Young has transfer pricing professionals in all regions of the world. We are experienced in the global management of transfer pricing policies and Revenue Authority enquiries. Wherever you are doing business, we are able to help and assist you to keep pace with the changes.